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Accounting for Idiosyncratic Wage Risk Over the Business Cycle

Alisdair McKay () and Tamas Papp ()
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Tamas Papp: Institute for Advanced Studies, Vienna.

No WP2011-028, Boston University - Department of Economics - Working Papers Series from Boston University - Department of Economics

Abstract: We demonstrate that wage volatility, measured as the cross-sectional variance of wage changes in PSID data, is counter-cyclical. We quantify this relationship by estimating the re- gression coecient of wage volatility on the national unemployment rate in a multilevel Bayesian model, then decompose this coefficient into three main factors. During a recession, wage volatil- ity increases substantially among those workers experiencing spells of unemployment: the cycli- cal changes in the variance within this group explain about 55% of the cyclical variation in wage volatility. The variance within the group not experiencing unemployment explains 18%. Finally, an increase in the fraction of workers experiencing unemployment explains 25%. We show that a calibrated search-and-matching model of the labor market with on-the- job search gives a good account of the cyclical variation in idiosyncratic wage risk among those experiencing unemployment and of the composition effect over the business cycle. We show that in our model, this result is driven mostly by uctuations of the reservation wage in response to labor market conditions.

JEL-codes: C11 E24 E32 J64 (search for similar items in EconPapers)
Date: 2011-01
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